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Wednesday, August 12, 2009

Emergency Fund

The question that I am posing, and hoping to answer, is how much money is enough for your emergency fund. An emergency fund is intended to be used, of course, in an emergency. My definition of an emergency is a) when you lose your job, b) when something unexpected happens, c) a cushion in case of unintended expenses.

A good suggestion that I got from Million Dollar Journey is to begin by having $1000 in an emergency fund, then pay off your loans, etc. By having $1000 set aside, you should never need to go to your credit card, or lines of credit or anything like that in the case of an emergency. If your motor goes on your car, or you need to buy a new roof or whatever, this money is intended for stuff like this, so you don't need to borrow in order to cover it.

In these tough economic times, there is a threat for everyone of losing his or her job. Of course, you are saying, "This could never happen to me", but for everyone that is a realistic concern. I would recommend having at least three months expenses saved up in an emergency fund in case of job termination. What are three months expenses? Basically these are your fixed expenses (less investments): mortgage (or rent), food, monthly bills, loans, etc. If you lose your job, likely investments and variable expenses will be pulled back. In three months, you should be able to recover financially and find another job (one would hope).

In the same way, if you have a rental property, you should also have an emergency fund set up. What this fund will be is at least three months worth of rent. This should cover if there are unexpected vacancies, as well as some money left in case of emergencies (or maintenance). You don't want to have to tip into your personal finances in order to maintain your property, or if a month or two goes by without any renters, so if you are going this route, please make sure that you have enough float cash to cover.

Some people use a line of credit for an emergency fund. I would recommend against this as a shift in mentality. If you have money saved for your emergencies, it is much more positive than having to borrow money for emergencies. It is another level of freedom that you wouldn't otherwise have. If you lose your job, do you really want to have to pay back a line of credit?

My recommendation to everyone is to open up a Tax Free Savings Account and put $1000 in there (or at least contribute every paycheque until you are there). Then if something bad happens and you need some cash, you will have it. Remember to try to minimize your consumer debt!

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